Mixed news reports have made investors unsure about their appetite for risk assets: Positive stories in the form of strong US corporate earnings have had to fend with the lack of progress on US President Biden’s (already scaled-back) spending plan and worries over rising Covid cases.
Also damping risk appetite: Supply-chain disruptions and the related concerns over stagflation–US third-quarter GDP growth in the US was lower than expected at only 2.0%. These worries have caused a repricing of market expectations for major central bank policy rates.
Bond traders have sold shorter-term bonds and bought longer-term ones, as they increased their positions on a more hawkish policy stance from central banks. The yield on the US two-year Treasury has risen sharply since the beginning of October, while 10- and 30-year yields have fallen.
There has been a similar flattening in Canadian and UK yield curves on rising expectations that both central banks might raise interest rates early in 2022.
The gap between short- and long-term yields has narrowed in some major markets, including Germany. Though ECB President Christine Lagarde has pushed back, investors are positioning themselves for earlier rate rises in Europe, too, after eurozone inflation reached 3.4% in September and is now forecast to hit a 13-year high of 3.7% in October.
There is one place where inflation expectations have remained low and that is Japan. The Bank of Japan has kept its policy unchanged. It expects inflation to remain at below its 2% target for at least two more years, allowing it to keep its policy stimulus in place for longer.
Supply chain disruptions continue
Supply constraints have continued to interrupt production and global distribution and have kept price pressures high. This has caused some market participants to question whether rising inflation is actually transitory, which is what central banks are telling us. After the release of lower-than-expected Q3 growth in the US, China’s PMI data has also pointed to a further slowdown in economic momentum.
While China’s power shortages are a major factor disrupting production and global supply chains, the effects are felt more so in the US (see Exhibit 1), which can be seen as indicative of the developed world’s supply constraints. All this is affecting inflation expectations, prompting some investors to expect inflation to be higher for longer and to worry about the emergence of stagflation.
China nudging towards more policy easing
Weakening growth due to sporadic surges in Covid-19 infections and power shortages are pressuring Beijing to ease policy further, albeit selectively. It has instructed banks to ‘avoid overly severe’ curbs on property lending and ‘maintain positive growth’ for development loans. These are loans to developers to build homes, but not for mortgages or buying land, to ensure they can deliver pre-sold homes.
This is a fine-tuning move to ease the policy restrictions for the property market. It should not be seen as major policy easing. It shows Beijing’s cautious stance in order to avoid a potential systemic credit crunch and an economic hard landing caused by the problems in the property sector.
Arguably, Beijing’s economic pain threshold is now higher than before as the authorities appear more willing to trade short-term pain for long-term gain.
This macroeconomic backdrop has continued to hurt Chinese stocks. The market may remain rangebound until new catalysts emerge. These may include:
1) A turnaround in the credit impulse, which will mean further monetary easing
2) An increase in local government bond issuance, which will improve total credit growth and, thus, investment spending
3) Positive developments in Sino-US relations in terms of trade/tariff negotiations.
What’s at stake at COP26?
With the global climate summit in Glasgow now in full swing, the world is keeping a close eye on two main areas:
1) The negotiated outcomes relating to the outstanding issues in the Paris Agreement rulebook
2) Whether adequate finance flows to developing countries for green development are agreed.
Attention will also focus on any country’s pledges to reduce emissions in line with the Paris Agreement’s goal to limit the rise in global temperatures to 2.0C, and preferably 1.5C, to prevent future climatic disasters.
Discussions in Glasgow are important, as are the actions of investors in support of the required future technologies, stewarding the organisational changes needed, and advocating for effective policy changes that also facilitate a just low-carbon transition.
Most importantly, the actions all foster real change in the real economy so that the emissions cuts needed to get to net-zero are delivered.